Ten Notes on Crude

David Merkel has a good Sunday morning read posted Ten Notes on Crude Oil: The Fixation:

In different economic eras, different things attract the attention of the media, investors, politicians, etc.  Today a leading attention grabber would be crude oil, and the energy complex.  It is a honeypot for conspiracy theorists and unscrupulous politicians (not quite an oxymoron).

Reading all 10 this morning is a worthwhile exercise.

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Previously:
The Costanza Energy Policy: 25 Ways to Drive Oil to $150
http://bigpicture.typepad.com/comments/2008/05/how-to-drive-oi.html

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Discussions found on the web:
  1. Jim Haygood commented on Jun 15

    Probably the single most important geopolitical development of the past 30 years is the emergence of China and India as trading nations. Hundreds of millions who had barely participated in the currency economy are now entering the middle class. But this development is mostly taking place using the energy-intensive example of the West.

    If energy supplies were highly elastic, the rise of China and India wouldn’t have been a big deal. But energy, from exploration to refining, is a capital-intensive business. And as Merkel noted, many countries impose below-market energy prices which subsidize consumption.

    The ultimate question, which receives surprisingly little attention, is whether a global population of 7.5 billion now — or 9 billion in 2050 — is sustainable. The question is exceedingly complex, and there is no more consensus on the answer than there is on climate change (which would affect the answer). But if the subject is placed off-limits for debate, then the extrapolated future looks like an endless treadmill where you have to run faster and faster finding oil and gas to support the rising population and rising living standards of the developing world, without making progress on affordability.

    Doesn’t leave much margin (if any) for rising living standards in the ‘rich countries,’ does it?

  2. zackattack commented on Jun 15

    Over the short term, I don’t think it’s wise to get big long oil after a week where we see “CNBC Special: America’s Oil Crisis,” Congresscritters calling for the heads of speculators and even Ben Stein weighing in on the topic.

    These are not signs of a bottom.

    What I actually *did* was sell a coal company that traded like a biotech and had tripled in 18 months.

    Over the long term, bubbles tend to follow a rule of 20x. The South Seas company was almost exactly a 20x rise in share price. The Nasdaq went from 300 to 5100. Gold in the 70s ran from 35 to 800. There are countless examples.

    But we’ve never really seen a bubble in something essential to the world before. All these others were essentially financial instruments. Even oil in the 70s was an OPEC protest against the US dropping the gold standard; the taps could’ve been turned on again at any second.

    The only counterexample I can recall of something essential is Peruvian anchovies in the 1980s, essential to fertilizer. But I can’t seem to find any cost data on that.

    So, longer term, I would expect oil to see at least $250 until the end of the decade trade, perhaps with some overshoot.

  3. ChimpChumpChang commented on Jun 15

    >>>I would expect oil to see at least $250 until the end of the decade trade, perhaps with some overshoot.

    One certainly must wonder just how DEEP of a depression that would cause.

    Hmmmm….turn of the century….countries trying to maintain supremacy in oil supplies…..bankers running amok….systemic instability…..am I talking about WW1 or WW3? Do we ever learn?

    The answer is no. Because “we” aren’t the cause…”they” are. Why run up another flag when the Jolly Roger works so well?

  4. zackattack commented on Jun 15

    Another piece of sentiment data…

    Dubai building the world’s largest airport. Why would they need twice the capacity of O’Hare?

    Abu Dhabi buying urban US office buildings.

    Where have we seen this picture before? Methinks these boys are getting a little too cocky, perhaps like Japan in 1989.

  5. cinefoz commented on Jun 15

    Yes, it is a worthwhile exercise, but that’s about all. Nobody is claiming that oil is not a finite resource that is in high and growing demand.

    This article is just another example of armchair intellectual analysis … the lazy but intelligent person’s way of solving problems. Read some books, draw up a theory, see if it feels right in the gut, see what others are saying, and then do what the lizard brain says and provide a think piece that summarizes some aspect of ‘what everybody knows’. Then follow the crowd up a rising market and feel smart about it. (Didn’t that recently happen in another industry or two?)

    So far, nobody has a definitive answer, just a lot of speculation about speculation. It is surprising, though, how so many ignore oil’s fantastic price increases over the very near term but claim that speculation is simply not the case here. Even though there are no shortages, lines, or refinery bottlenecks. It must be the damn Chinese, or so the conventional wisdom goes.

    When Congress closes a few avenues of speculation, it will not ruin the price finding mechanism and liquidity provided by the futures markets. It will just make it more difficult for oceans of money to find a way into a market that can use, but does not need, the extra capital.

    At that point, we should all know if this is a commodity bubble or not. I’m betting on the bubble. My gut is an excellent bullshit detector and it hasn’t wavered since oil passed $115. At $110, oil should have headed in the other direction.

    One more thing … oil without a refinery is useless stuff. From what I hear on financial tv, refineries are not particularly hot investments. Some say they are being victimized by high oil prices as much as the consumer. This implies a competitive market for refinery services, and not an industry with pricing power. Thus, shortages for refined product are somewhat imaginary. Thus, oil prices are high for little reason.

  6. dblwyo commented on Jun 15

    That’s a good survey. My view is that more than sufficient reserves are available but existing ones are aging and declining due to under-investment. And that the potential new ones are trapped behind political barriers that prevent appropriate investments in exploration and production. As a result we’re going to be on the ragged edge of S/D imbalance for a long-time until a concerted effort is made to transition to alternatives – which will take $Bs and decades if we muster the will. If you’d like the back readings, sources and analysis try these three blog posts:
    Energy & Oil:
    Oil Industry I: Prices, Fundamentals http://tinyurl.com/5wxuo9
    Oil Industry II: LT Supply-Demand, Outlook http://tinyurl.com/5jcah5
    National Energy Policy: http://tinyurl.com/5kcv6a

  7. techy commented on Jun 15

    cinefoz….

    why dont you short oil then?
    even though that will again be speculation since you cannot supply oil.

  8. cinefoz commented on Jun 15

    Weren’t home prices going up a while back because they weren’t making any more land? I even fell for that one a couple of years ago. Live and learn.

  9. Mel commented on Jun 15

    The eleventh note should be that there will be more energy/oil wars–Iraq is just the first one this go around. Too much money and resources are now in the hands of defenseless sovereigns. The US and China will use their military might for energy–as will local “liberators.”

  10. cinefoz commented on Jun 15

    This paragraph is worth a post of its own. A quick look at VLO makes one think of home builder charts. That’s pretty odd for a business that is intimately connected with a commodity that is in critical demand, isn’t it? Or is there a solid reason why oil should be in high demand, but much less for refined products?

    Oil without a refinery is useless stuff. From what I hear on financial tv, refineries are not particularly hot investments. Some say they are being victimized by high oil prices as much as the consumer. This implies a competitive market for refinery services, and not an industry with pricing power. Thus, shortages for refined product are somewhat imaginary. Thus, oil prices are high for little reason.

  11. cinefoz commented on Jun 15

    Or, to put it in terms even a stupid person can understand …

    How can there be a shortage of oil if there are no shortages of the things made from oil? Where are the allocation decisions? Are prices for refined products high because of demand that is independent of the base commodity, or are they just rising due to source material costs?

    If refiners are gouging on diesel fuel, where are the refiner profits hiding?

  12. VennData commented on Jun 15

    Barack Hussein Obama plans to make food for the 3rd World’s poor from light sweet crude pumped, refined, and shipped from here in the US so watch your wallet.

    Full Disclosure: I am NOT a McCain plant. This is not a smear (well, a Semi-partial Disclosure.)

    http://blog.wired.com/27bstroke6/2008/06/there-probably.html

  13. DownSouth commented on Jun 15

    When it comes to all the cacophony in regards to oil prices, I’ve noticed one overriding trait of the debate–advocacy trumps inquiry. The vast majority are only interested in peddling some pet nostrum. Getting to the bottom of what is actually going on is of no concern.

    The oil bulls have their zealots, but the oil bears are insufferable. One would have to believe in witchcraft in order to buy into some of the arguments the bubble theorists make. These guys paint with a really big brush, as if tulips play the same role in the economy as oil does.

    The desire to win the argument is so strong that it drives many to fudge the numbers. I read all the time that you can produce a conventional barrel of oil for $20 or a barrel from the Athabasca Tar Sands for $50.

    This is a distortion at best, an outright lie at worst, as anyone who knows how to read a financial statement can gleen with about half an hour’s research. Don’t believe me? Just go take a look at Suncor’s 1Q08 financial statments–$56 per barrel in operating cost alone for its Canadian tar sands production. Of course this doesn’t include any return whatsoever on the massive investment required to produce that barrel of oil. I suppose, using the logic of the bubble theorists, the stockholders of Suncor deserve zero return on their investment.

    And maybe you can produce a barrel of oil in Saudi Arabia or Kuwait for $20 per barrel, that is a barrel of proved devoped reserves. A quick look at the financial statement of any domestic independent oil and gas producer belies this claim for domestic production, however. Twenty dollars a barrel won’t even cover production costs. And in a rare moment of honesty and frankness from the oil industry was this note the other day:

    “ConocoPhillips said Thursday that rising exploration and production expenses are increasing the cost of adding crude output to $100 a barrel.

    “A weak dollar, rising prices for commodities needed to build oil infrastructure and fewer resources to search for new deposits are to blame, John Lowe, executive vice president for exploration and production at Houston-based ConocoPhillips, said at a conference sponsored by sanford C. Bernstein & Co.

    ” ‘You add all those factors up, and you get an incremental cost of supply somewhere in that $90 to $100. And I think it’s moving higher, not lower,’ Lowe said.” (Houston Chronicle, “Producing Oil Grows More Costly,” May 30, 2008, page D4)

    Of course the bubble theorists dismiss this as exculpatory rhetoric from a dishonest oil executive, which might hold water, except for the fact that ConocoPhillip’s and every other oil company’s financial statements back up what Mr. Lowe is saying.

    So unless for some reason Saudi Arabia can be convinced to open the tap (that is assuming they have any tap to open), there’s not much relief in sight on the supply side.

    That leaves the demand side. Here is where the oil bulls get carried away. They seem to think that people will just go on using oil priced at $250 per barrel as if there were no tomorrow. But the last time we had a big run up in prices it did cause demand destruction. The 1100% increase in price in the 1970’s and 80’s caused a 13.5% decline in consumption. They claim it’s different this time. And maybe it is. But the situation is so complex that one would have to be a fool to risk their reputation on predicting future demand. But many oil bulls have no problem dismissing out of hand even the remote possibility that oil demand may dimish.

    Truly, when I feel these guys get going, I feel like I’m hearing a passionate argument over religion instead of the dispasionate discourse one would expect from someone talking about something as mundane as oil.

  14. mickslam commented on Jun 15

    How about this for a conspiracy theory?

    Is the DOE filling the Stragetic Oil Reserve as a boost to Oil prices so the Oil countries are compensated for taking risk to purchase U.S. financial assets?

  15. KJ Foehr commented on Jun 15

    “How can there be a shortage of oil if there are no shortages of the things made from oil?”

    There doesn’t need to be a shortage for prices to rise; was there a shortage of houses? Gold? Shares of stock? An increase in demand for oil is enough to cause the bid to rise.

    “Oil without a refinery is useless stuff.”

    From what I have read / heard, we have not built a new refinery in the USA for decades, but what about China, India and TROW? Could they have excess capacity?

  16. cinefoz commented on Jun 15

    OR, if you want conspiracy theories, maybe the USA wants oil prices to escalate astronomically to piss off China. The price of gasoline is subsidized in China, or so they say. If China were forced to allow Chinese consumers to pay full price for gas because it became too expensive to continue the subsidy, then this would force some inscrutable neocon objective down the throats of the Chinese and a few crazies in the USA would smile a little. Thus, a few nutball neocons want to the world to choke on high oil prices just to bust the balls of the leaders of China?

  17. VJ commented on Jun 15

    cinefoz,

    One more thing … oil without a refinery is useless stuff. From what I hear on financial tv, refineries are not particularly hot investments. Some say they are being victimized by high oil prices as much as the consumer.

    UH HUH.

    Just as one example, back in the Spring and Summer of 2000, gasoline prices spiked, nearly doubling in the Midwest. We heard the same old tired refrain from Big Oil and their compatriots, such as “shortages of reformulated gasoline“, “refineries closed down for maintenance“, “increased demand“, and “there is a shortage of gasoline refineries because the environmentalists/Democrats are blocking any new construction“.

    Amid growing suspicions of manipulation, the Clinton administration ordered the Federal Trade Commission to launch an investigation, promising prosecution if price-gouging or market manipulation were involved. After a six-month investigation, the FTC completed the investigation, but the current administration refused to release the report, until a court ordered it to be released in response to a FOIA application.

    What did the FTC find ? That refiners had INTENTIONALLY withheld gasoline inventories from the market to maximize profits. The current administration was of the opinion that it was NOT ILLEGAL.

    What were the results of this fraudulent manipulation of the market, which caused consumers to pay double for each gallon of gasoline ? Refiners, such as Diamond Shamrock, saw earnings increase 310%, while Sunoco saw earnings increase by 743%.

    I’ve seen no evidence that these tactics have not continued since.

    This implies a competitive market for refinery services, and not an industry with pricing power. Thus, shortages for refined product are somewhat imaginary.

    Hardly.

    From 2000 to 2003, Big Oil reduced their gasoline refining capacity by 60%. In 2000, there were about 350 gasoline refineries in this country, and as of 2003, there were only about 140 gasoline refineries. Additionally, there have been multiple reports that Big Oil has reduced the operating capacity of the remaining gasoline refineries from 89% at the beginning of this year, down to 85% by Springtime. American gasoline refineries can be safely and routinely operated at above 93% capacity.

    As ABC News Business Correspondent Betsy Stark stated on the April 29th, 2008 ABC World News:

    experts say it’s the big oil companies that are reluctant to build any new refineries
    .

  18. VJ commented on Jun 15

    DownSouth,

    So unless for some reason Saudi Arabia can be convinced to open the tap (that is assuming they have any tap to open), there’s not much relief in sight on the supply side.

    The Saudi Minister of Oil has repeatedly stated that there is no shortage, that they have large inventories of crude available for purchase, and that their biggest problem is a LACK OF BUYERS. However, they are now supposedly planning upon increasing production (between 200,000 and 500,000 barrels daily, depending upon the report), but the Saudis themselves say they are only doing it to placate their customers calls for increased production, that they do not believe it will impact the price of crude or gasoline, as there is already a global glut of oil.
    .

  19. Mitch Nauffts commented on Jun 15

    Venn Data wrote:

    Barack Hussein Obama plans to make food for the 3rd World’s poor from light sweet crude pumped, refined, and shipped from here in the US so watch your wallet.

    So, dude, what’s your middle name? For that matter, what’s your real name? Rex Tillerson? Rush Limbaugh? What are you hiding?

  20. wunsacon commented on Jun 16

    Yeah, Venn. You write some intelligent posts. Why, in a post critical of Obama, do you write out his full name? That’s the rhetorical flourish of a Yahoo poster! ;-) Not you. (Well, maybe Barack’s mom used to call him that, too.)

    Cinefoz, you raise some good questions. I guess I wonder whether refinery capacity additions around the globe and a shortage of sweet crude helped make it unprofitable to refine here in the US.

    VJ, DownSouth, interesting posts. Thanks.

  21. wunsacon commented on Jun 16

    VJ, weren’t some refiners (VLO, for instance) near the brink of bankruptcy back in 1999? For any of the refiners to stay alive, I would expect (a) SOME refiners to go out of business AND (b) the remaining refiners to improve margins significantly — very large percentage moves from a base of “near zero”. (As an analogy, consider today’s relationship between airline capacity and airline margins: some airlines must go bankrupt in order for the remaining to start earning their cost of capital.)

    So, while you might be correct in concluding something improper was afoot, I’d first have to see more detail before agreeing.

  22. VJ commented on Jun 16

    wunsacon,

    VJ, weren’t some refiners (VLO, for instance) near the brink of bankruptcy back in 1999?

    But why ? Was it bad management, undercapitalization, misfortune, or what ? One shouldn’t extrapolate an allegorical example to the entire market. After all, crude was $11/barrel, there was a rising demand for gas, the economy was booming, we had peace and prosperity, cotton was high, and your mama was good lookin’.

    How the hell do ya screw that up ?

    For any of the refiners to stay alive, I would expect (a) SOME refiners to go out of business AND (b) the remaining refiners to improve margins significantly — very large percentage moves from a base of ‘near zero’.

    Sure, any business is subject to the vicissitudes of the market, so it would be natural for SOME refiners to fold, but over 200 of what were 350 existing refineries ?

    (As an analogy, consider today’s relationship between airline capacity and airline margins: some airlines must go bankrupt in order for the remaining to start earning their cost of capital.)

    A good chunk of the airline business is discretionary, whereas with constantly rising demand for gasoline, its production was almost a utility. There was a need for MORE refineries, not fewer.

    while you might be correct in concluding something improper was afoot…

    It was the FTC that documented the refiners manipulation of the market by withdrawing inventories to maximize profits.
    .

  23. David Merkel commented on Jun 16

    Hey Barry, thanks for featuring my piece. I’m offline on Sundays, so I was really surprised at the amount of feedback till I noticed your article. Thanks again!

    PS — Interesting the difference of opinion on market manipulation, and the opinions are heated. My opinion: markets can be manipulated in the short-run, but can almost never be manipulated in the long run, because end user/producer supply and demand take over.

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